A Semiautoregression Approach to the Arbitrage Pricing Theory

ABSTRACT

This paper developes a semiautoregression (SAR) approach to estimate factors of the arbitrage pricing theory (APT) that has
the advantage of providing a simple asymptotic variance‐covariance matrix for the factor estimates, which makes it easy to
adjust for measurement errors. Using the extracted factors, I confirm the finding that the APT describes asset returns slightly
better than the CAPM, although there is still some mispricing in the APT model. I find that not only are the factors “priced”
by the market, but the factor premiums move over time in relation to business cycle variables.